No Simple Remedies

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Here we go again. After nearly a decade of relatively moderate price increases, health-care costs and insurance premiums are set to skyrocket. And this time, the situation could be worse for employers than it was in the 1980s, says Stuart Altman, professor of health-care economics at Brandeis University and a senior health-care adviser to Presidents Nixon and Clinton.

In the 1980s, there was at least the prospect of a new managed-care model that might slow the growth in health-care expenditures. The model even worked for a while. Between 1995 and 1997, the annual growth in health-care spending was a tolerable 3.5 percent, though since then it has steadily climbed: it reached an estimated 9.3 percent last year.

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In the process, however, the managed-care industry has become public- enemy number one–demonized as bureaucrats who compromise public health for the sake of corporate profits. The health-maintenance organizations and the insurance industry are now despised by medical practitioners and consumer groups alike.

That animosity is about to wreak havoc with corporate health- insurance premiums. With no government or marketplace constraints, health-care providers are in a position to raise rates as much as they see fit. And rather than fight it, insurers are simply passing the costs along to employers. In fact, in many regions, private insurance premiums are rising faster than the underlying costs, as insurers play catch-up for lagging costs in the mid-1990s. The California Public Employees’ Retirement System (CalPERS), for example, one of the most powerful insurance buyers in the country, had to fight the California HMOs tooth and nail to limit its increase in premiums to 13 percent this year. Small businesses are facing hikes of up to 30 percent.

What’s to be done? With no intermediary willing to battle with the health-care providers, employers will have to fend for themselves. CalPERS has decided to double out-of-pocket fees for visits to the doctor to $10, and it is also increasing co-payments for prescription drugs. Other employers will undoubtedly have to consider more drastic measures. And while few companies have yet to take the radical step of switching to defined contribution plans, in which employees are responsible for any increases over an agreed-upon amount, that could soon change. Altman calls defined contributions “the only new nirvana out there today” for employers facing runaway health-care costs.

CFO senior editor Andrew Osterland recently spoke with Altman about the current economics in health care, and about how employers are dealing with an increasingly difficult situation.

Health-care costs are expected to increase, on average, about 10 percent this year. Some small businesses are facing 30 percent hikes in insurance premiums. This comes after almost a decade of relatively modest health-care inflation. What happened? We went through a period of rapid increases in health-care costs through the 1980s until about 1992. The percentage of our gross domestic product spent on health care, in fact, went from about 9 percent in 1980 up to almost 14 by 1992. Experts, including myself, were predicting that based on then- current trends, we would hit 16 to 18 percent by the year 2000. But beginning around 1993, because of the pressure of managed care, combined with limitations on government spending, health-care spending as a whole began to flatten out. How did those pressures translate into lower costs?

It was a fundamental transformation. Managed-care companies began limiting what they would pay to health-care providers for the services used by privately insured patients. Hospitals, faced with these revenue limitations, controlled their cost growth for the first time. There was a recognition on the part of the medical community that they could do things differently and that they could restructure the kinds of care they provide.

So what’s changed now to refuel the growth in costs and premiums?In the beginning, the managed-care companies were making money hand over fist. But they weren’t raising premiums, and their underlying costs began to creep up. Before they could adjust, their costs were greater than their premium revenues, and profits turned to losses. Now they’re trying to catch up big-time. They’re raising their premiums more than the growth in their costs. The providers–hospitals, doctors, home health-care providers–are also trying to catch up, and they’re pushing private payers to pay higher rates. Add to this the consumer and political backlash against managed care, and I see nothing standing in the way of providers and insurers raising their prices.

Is the managed-care model no longer capable of limiting health-care inflation?It’s not the model. The model has value. The problem is that managed care is really on the ropes. Consumers don’t like it. The politicians don’t like it. And the employers are now finding they’re not saving as much as they’d hoped. Consequently, many employers are moving from strict managed-care plans to PPOs [preferred provider organizations] and modified fee-for-service plans. During good economic times, when profits are flowing and you have a labor shortage, employers don’t care much about squeezing the last nickel and dime out of their health-care budgets.

The question now is, with this downturn and with premiums going up, will employers want tougher managed-care plans, and how will managed- care companies respond? If they all just offer PPOs and modified fee- for-service plans, nothing will happen. But if some companies come back to employers, now seeing double-digit increases in insurance premiums, and say “we really do think we can do a better job at managing costs, but you the employer have to be tougher with your employees”–what will employers do?

What alternatives do employers have to deal with these rising costs? Their options are limited. They could just continue to provide the benefits they provide now. They could start asking employees to pay more in premiums, and they could introduce more co-payments. Or they could go toward what are called defined contribution plans, where the employer agrees to pay only a fixed percentage growth in premium, say 5 percent. And if the actual premium increases are greater, say 10 or 15 percent, the employees pay the difference.

Which employers are most likely to switch to such plans?Well, we haven’t really seen a lot of it yet. But I think it will start with the small businesses and in the weaker sectors of the economy. It’s going to be harder for employers that are in fast-growing sectors with labor shortages or employers facing strong unions. The unions are concerned that this will be a permanent change, and that henceforth they will lose what they call an “entitlement.” It’s an economic issue, but it’s also an emotional issue for workers. Going to these defined contribution plans is not going to be a slam dunk.

Some people have suggested that the managed-care bureaucracy was so big that it countered the cost-savings that it was generating. Is that accurate?If that were the case, we wouldn’t have seen such a fallback in spending. There’s no question there is bureaucracy, and in some cases, it probably hasn’t been cost-effective. But in many cases, it clearly has. Over time, though, the medical community figured out how to beat the utilization controls imposed by the managed-care companies, or complained bitterly that they were being micromanaged. So the managed- care industry said “OK, if you don’t want us to second-guess your decisions, we’ll let you decide. We will give you–the doctors–a fixed amount of money, and you decide what you need to provide as services and how much is available for specialists and for hospital care. You manage that money if you think you can do a better job.”

The problem was that if you started giving it to individual physicians, they could get financially destroyed if they wound up with a bunch of sick people. So the doctors began forming medical management companies with groups of 10 to 20 doctors or more. But it turned out that many of these medical management companies had problems as well. Eventually, the doctors said they didn’t want to be in this business.

So the managed-care companies essentially passed the responsibility for managing costs on to the providers who failed at the job? What happens next?We have three choices. Either we pay for everything that the doctors or medical providers believe is necessary; we manage it centrally, either by the government or by an insurance company; or we give the responsibility to the medical communities, and give them resources but with a fixed budget. Right now, we are moving back to letting medical professionals decide what is necessary with little or no budget constraints.

What is actually driving the underlying cost trends, then? Increased utilization? Aging baby boomers? Prescription drugs?It’s everything. This is a profession that believes it is doing good. And with new and very expensive techniques and drugs at its disposal, doing good is very expensive. We as a population want more of those services, even though there’s a lot of evidence that more is not always better. But if a doctor says there’s a slight chance your headache might be more serious, and gives you the choice of either taking aspirin to see if the headache goes away or having an MRI, which costs a thousand bucks, the average person wants the MRI. Often now doctors tell patients to have the MRI before they even see them.

Does our market-based system inevitably raise costs because doctors want to go into the specialties in which they can make more money and make use of more expensive technology?First of all, it’s not what we normally think of as a market-based system. Markets require people to make choices and to have budgets and constraints. When you buy a computer, you’re using your own money. But when you talk about health care, it’s going to be paid for by a third party. The forces that you count on for a market to work aren’t there. And this country uses specialty care more than any other country. At times, insurance companies have acted to limit spending because employers put pressure on them not to raise premiums. They, in turn, have gotten tough with how much they paid health-care providers and whether they permitted a specialist to provide service. Such constraints led to a brief increase in the number of new physicians selecting primary care as their career. That was the managed-care revolution of the mid-1990s and that is what has broken down now.

How do we fix it?We as a society have to decide if we want to put constraints on the system and who we want to be the gatekeepers. Right now we are still beating up on the previous gatekeepers–the private managed-care companies. With no one playing that role, we are going to spend more on health care and increase the proportion of our national income going to health-care services.

How long can we as a country afford our health-care expenditures?I don’t know. When I was 32 years old, I became the chief regulator in this country for health care. At that point, we were spending about 7 1/2 percent of our GDP on health care. The prevailing wisdom was that we were spending too much, and that if we hit 8 percent, our system would collapse. You know what? The system didn’t collapse. We passed 8 percent, 9 percent, 10 percent. We are now at about 14 percent, and neither the health-care system nor the economic system has collapsed. I know as an economist that the more you spend on one thing, the more pressure it puts on other things. But I no longer believe there’s a magic number we can’t surpass. I think the issue is less what proportion of GDP we spend and more how fast such spending is growing.

How did the Balanced Budget Act of 1997 affect Medicare, and how is it doing today?The Balanced Budget Act [BBA] was extremely successful in reducing government spending on Medicare and in building up reserves in the Medicare trust fund. History may say it was too successful. The reductions in government spending were greater than expected, and as a result, government has already passed legislation twice to give back some of the cuts to various health-provider groups. In 1995, it was projected that Medicare would go broke in 2002. As a result of the BBA and a robust economy, the expected bankruptcy has been pushed back to 2029. But this may change.

Now that the economy is slowing down, wages are sure to grow less rapidly. This will reduce the projected revenues for the trust fund. On the spending side, the two give-backs, and the fact that the BBA is scheduled to end in 2002, mean that more money will flow out of the fund. I don’t know how quickly the trust-fund bankruptcy date will reverse itself, but it would not surprise me to see the date fall to 2015.

How does a change in the Medicare situation and the issue of large numbers of uninsured Americans affect the insurance costs of private employers?If Medicare tightens its payments and the number of patients without health insurance grows, health-care providers will seek to raise the prices they charge private patients. Without an aggressive private insurance market, they are likely to be successful. As a result, private insurance premiums will rise and likely lead to further increases in the uninsured. This doesn’t always happen; it depends in part on the economy. If health-care costs rise and the economy is strong, employers are more likely to pay the higher premiums. If the economy is weak, it will likely generate large increases in the uninsured.

And the costs for those uninsured patients will be shifted to insured patients?Yes, it becomes a vicious circle. It reinforces the pressure for cost-shifting to the private sector, which reinforces the increases in the premiums for the insured, leading to more uninsured.

Is there no law against this cost-shifting?As of today, aside from Maryland, all states have repealed their rate-regulatory systems. If I’m a hospital, and 5 percent of my costs are for the care of patients who can’t pay, there is no law that stops me from charging more to my private patients. Quite the contrary; we implicitly depend on such cost-shifting to keep the quality of care high in these institutions.

So they could theoretically charge $3,500 to stitch up a hand?That’s right. Hospitals charge more for paying patients, and they particularly charge more for emergency care. When managed care was at the height of its power, it was able to minimize such cost-shifting, which made employers happy. But everyone else was unhappy. Now, patients and providers are somewhat happier, at least temporarily, but employers are waking up to what is happening. Ultimately, higher private charges are going to be shifted back to employees and patients. Then we will see what happens. I predict by the next Presidential election, rising health-care costs and the growing number of uninsured will be major issues.

Who wins and loses in this situation?If you’re in the delivery or patient system, you’re happy, because more money is being spent. If you’re part of the payer system, you’re not going to like it, because you’re the one paying more money. It’s hard to stop. We haven’t had the political will to accept what it means to hold health-care costs down. Everyone has a way of pointing fingers at somebody else.

What is the bottom line for CFOs worried about their employee benefit costs?CFOs are going to have a tough time trying to bring their health- care premiums under control. They’re not going to have any help from either the government or from an aggressive managed-care insurance market. They’ll have to either pay more, cut benefits, or ask their employees to pay more. There is no good answer. The CFO of today is going to be in a situation similar to his predecessors of 1985. In many respects, it could be worse, because in 1985 CFOs were beginning to hear about this bright, new world of managed care. And while most firms had only limited experience with it, there were benefit consultants championing this new nirvana. The truth is, the only new nirvana out there today is defined contribution insurance. And defined contribution plans will be heavily opposed by employees and unions.